Institutional investors no longer afraid to take action

Pension funds and other institutional investors have been more active through the recent period of volatility and uncertainty than they were in 2008.

That's partly explained by an environment that's less severe than the global financial crisis three years ago. But experts say investors learned from 2008 and have become better equipped to actively invest through periods of market distress.

“People are not "deer-in-the-headlights' like they were in 2008,” said Mark Keleher, CEO of both Mellon Transition Management and BNY Mellon Beta Management, San Francisco. “Although we're certainly not in a great economic world right now ... people are taking a much more measured approach.”

Investors on both sides of the Atlantic postponed some typical investment decisions in August, especially decisions on rebalancing, according to transition managers.

“Every year at this time we have a rush of transition events as asset owners are rebalancing their portfolios getting ready for the next year,” but not this year, said Michael Gardner, managing director, global head of strategic implementation and regional head of transition management for EMEA at J.P. Morgan Worldwide Securities Services, London. Activity was brisk in 2011 until about August, when things stopped, Mr. Gardner said.

“We definitely saw (pension funds delaying rebalancing) in August, where several plans pulled back from executing some decisions,” Mellon's Mr. Keleher said. But as of early October, “we're seeing investors returning to transitioning assets.”

Search and hire activity has not slowed down. Tracker Hiring Analytics data show publicly known search and hire activity as being roughly on par with historical averages, according to data provided by Eager, Davis & Holmes LLC, Louisville, Ky.

“Institutional hiring activity is driven by long-term strategy. Hiring activity levels in the past haven't responded to market events month to month or even quarter to quarter; it takes time,” David Holmes, partner, said in an e-mail.

Plan funding slumped to record lows in August and September, as equity routs and ever-climbing government bond prices caused assets to fall and liabilities to rise. The overall deficit of S&P 1500 corporate defined benefit pension plans in the U.S. grew to a record $512 billion as of Sept. 30, up from $507 billion a month prior, according to Mercer LLC. September's record high was more than double the $231 billion deficit as of June 30.

And in the U.K., the aggregate deficit of about 6,500 DB plans shot up 67% in the month of September to �196.4 billion ($306.9 billion), according to the Pension Protection Fund, the U.K.'s pension bailout fund. September's deficit neared March 2009's high of �208.6 billion.

But consultants say that investment opportunities can be created by market sell-offs, and that pension funds need to make their assets work harder because of shorter time horizons and a greater proportion of assets dedicated to matching liabilities.

“We're telling clients to accept a continued high level of uncertainty, so be nimble, be flexible. We're not in normal times,” said Tapan Datta, London-based principal, global asset allocation, at Aon Hewitt. Mr. Datta said Aon Hewitt has urged clients for years to stay more nimble, but that the global financial crisis and the recent period of volatility have probably driven the message home.

“Generally, there's greater understanding that timing does matter, even though you're not trading the market,” he said. “You're looking to benefit from the fact that markets move in cycles from being very cheap to very expensive.”

Andrew Kirton, president and global head of investment consulting at Mercer, said some funds are taking profits from gains in government bonds and reinvesting in stocks. “There's a growing view out there that we're at or we're near the peak of government bond valuations, and therefore you're rebalancing from an expensive asset to what could be a cheap asset.”

Mr. Kirton wouldn't call the current environment a crisis, in part because he doesn't “see anybody running around screaming,” he said. “There's a growing understanding that what we're in is a multiyear deleveraging process. As that appreciation grows, it feels less like a crisis and more like a heavy burden of issues we've got to work through.”

Whatever the current environment is called, “people seem to be keeping their heads together and asking what can we do ... and are not losing sight of the fact that the price you pay for investments should play a role in what (assets) you buy,” he said.

“You're seeing people go into equities and out of bonds because in some cases the bond-equity gap has moved so much,” added Andrew Belshaw, head of investments in London at Western Asset Management Co. He said client interest in global credit has been piqued by attractive pricing, too.

Said Aon Hewitt's Mr. Datta: “The attractions are beginning to appear to some extent in high-yield bonds. In emerging markets, there is some pain still to go through, but these assets are now beginning to reappear on our radar.”

An unpublished new study by Aviva Investors suggests U.K. pension funds could have boosted annual returns by 3.42 percentage points in the decade ended Dec. 31 by focusing more on forward-looking, dynamic asset allocation and less on manager selection.

“This is not tactical asset allocation; it's very much a model that reviews the strategic benchmark on an ongoing basis,” said Mirko Cardinale, head of strategic asset allocation research at Aviva Investors in London.

The strategy employs price-to-earnings ratios or similar current metrics to forecast long-term returns of respective asset classes. Those forecasts are used to tilt allocations toward cheap investments and away from expensive ones.

Currently, low-risk assets are expensive, but riskier assets don't look terribly cheap, Mr. Cardinale said. “They're not as attractive as at the beginning of 2009, but we're starting to see opportunities arise.”

Aviva runs a nominal �50.8 billion in a similarly managed overlay strategy for insurance and pension fund clients. Those real-world strategies outperformed their relative benchmarks by about two percentage points annually, Mr. Cardinale said. “It's something we've been able to verify with actual client” assets, he said.